ObamaCare Will Enrich Insurers At Taxpayers' Expense

The Affordable Care Act may give health insurance companies a virtually limitless power to tap the U.S. Treasury, thereby lifting insurers' profits to undreamt-of heights. This power derives from the mathematical formula for calculating individual subsidies.

The subsidy formula promises, for example, that a family of four with $30,000 in income will pay no more than 2% of that income (or $600) for its health insurance.

If an insurer charges $10,000 for a family policy, then, the family will pay $600 to the exchange, and the federal government will pay the remaining $9,400.

Under the medical-loss-ratio (MLR) rules, the insurer is entitled to retain 20% of the $10,000 (or $2,000) for overhead and profits.

Now here's the trick: If the insurer raises the premium to $20,000, the family still pays only $600. However, the U.S. Treasury will now pay the insurer a subsidy of $19,400 — and now, the insurer is entitled to retain 20% of $20,000 (or $4,000) for overhead and profits.

Now, the insurers' 20% take means the remaining 80% must go for medical expenses.

How does the insurer increase payouts from $8,000 to $16,000? It's easy: Pay higher prices to doctors and hospitals and drug companies. Allow, persuade, or even require patients to purchase a broader array of services. Require more tests, more surgeries, more everything, e.g., full genome mapping or spa visits for wellness.

The winners in this game are the insurers, doctors, hospitals, and drug companies. The insurance enrollee doesn't pay a penny more.

The only loser is the American taxpayer, who must shell out an extra $10,000 in subsidies.

Bad Incentives

But if you're the insurer, why not raise premiums to, say, $60,000? That's less than the cost of some family policies in the state of New York.

The family of four still pays only $600, but now the U.S. Treasury pays $59,400. The insurer can take home 20% of the premium, or $12,000. And from this one family, health care providers will now get $48,000 in revenue rather than $8,000.

For a family of four earning $90,000, the arithmetic is slightly different. Obamacare guarantees that they will pay no more than 9.5% of their income toward insurance premiums on the exchange. So instead of $600, this family will pay $8,550.

The U.S. Treasury gets off a bit easier ($7,950 less), but insurers and providers do just as well as they did with the lower-income family.

The Affordable Care Act may give health insurance companies a virtually limitless power to tap the U.S. Treasury, thereby lifting insurers' profits to undreamt-of heights. This power derives from the mathematical formula for calculating individual subsidies.

The subsidy formula promises, for example, that a family of four with $30,000 in income will pay no more than 2% of that income (or $600) for its health insurance.

If an insurer charges $10,000 for a family policy, then, the family will pay $600 to the exchange, and the federal government will pay the remaining $9,400.

Under the medical-loss-ratio (MLR) rules, the insurer is entitled to retain 20% of the $10,000 (or $2,000) for overhead and profits.

Now here's the trick: If the insurer raises the premium to $20,000, the family still pays only $600. However, the U.S. Treasury will now pay the insurer a subsidy of $19,400 — and now, the insurer is entitled to retain 20% of $20,000 (or $4,000) for overhead and profits.

Now, the insurers' 20% take means the remaining 80% must go for medical expenses.

How does the insurer increase payouts from $8,000 to $16,000? It's easy: Pay higher prices to doctors and hospitals and drug companies. Allow, persuade, or even require patients to purchase a broader array of services. Require more tests, more surgeries, more everything, e.g., full genome mapping or spa visits for wellness.

The winners in this game are the insurers, doctors, hospitals, and drug companies. The insurance enrollee doesn't pay a penny more.

The only loser is the American taxpayer, who must shell out an extra $10,000 in subsidies.

Bad Incentives

But if you're the insurer, why not raise premiums to, say, $60,000? That's less than the cost of some family policies in the state of New York.

The family of four still pays only $600, but now the U.S. Treasury pays $59,400. The insurer can take home 20% of the premium, or $12,000. And from this one family, health care providers will now get $48,000 in revenue rather than $8,000.

For a family of four earning $90,000, the arithmetic is slightly different. Obamacare guarantees that they will pay no more than 9.5% of their income toward insurance premiums on the exchange. So instead of $600, this family will pay $8,550.

The U.S. Treasury gets off a bit easier ($7,950 less), but insurers and providers do just as well as they did with the lower-income family.

Things change drastically for a family of four earning, say, $95,000. This family earns too much to qualify for subsidies. So if an insurance policy on the exchange costs $60,000, this family would have to pay that entire amount — but that's not a problem.

The insurer can simply sell policies inside the exchange for $60,000 and sell policies outside the exchange for $10,000. Subsidized families can purchase extremely expensive policies in the exchange.

Subsidized Greed

Unsubsidized families can purchase cheaper policies outside the exchange. (And, the insurer can still offer the $60,000 policy outside, knowing that no one will purchase it there.)

One other mechanism is supposed to prevent all of this from happening. The subsidies are limited to the cost of the second-lowest silver plan available on the exchange.

So if insurers A and B charge $10,000 and $12,000 for exchange-based policies, insurer C is effectively blocked from charging $60,000, because subsidies would only pay up to the $12,000 policy.

Yet, given these contorted rules, why would A and B actually sell policies in the exchange for so little? They, too, would know that raising their premiums will hit only the U.S. Treasury, not the actual people purchasing their policies.

Oligopolies often exhibit such strategic behaviors. Subsidized oligopolies exhibit this even more so. For that matter, why would a consumer buy the sad little $10,000 policy when the $20,000 or $60,000 policy costs him the same and provides a long list of gold-plated services?

Where would prices settle down? That's anyone's guess. But these rules pose a tremendous risk for the U.S. Treasury and, ultimately, for the taxpayers who fund that Treasury.

The Treasury has to cross its fingers and hope that insurers are fiercely competitive, but that's an iffy proposition.

Author's note: The strange ObamaCare math described here was first suggested to me by David Goldhill, CEO of the GSN television network and author of "Catastrophic Care: How American Health Care Killed My Father—and How We Can Fix It."

 Graboyes is a senior research fellow with the Mercatus Center at George Mason University and professor of health economics at Virginia Commonwealth University, the University of Virginia, George Mason University and the George Washington University.

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